ASX’s Blockchain Game Plan Could Lift Stock 44%

A man looks at electronic stock boards at the ASX in Sydney
Bloomberg News

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ASX Limited received a rare embrace from the sell side this week after getting no love from analysts over the past three months.

Despite the lack of upbeat ratings from analysts – ASX Limited (ticker:
ASX.AU
) had no bullish ratings between March and this week – the Sydney-based bourse has delivered an impressive outperformance this year. Shares of ASX have rallied 8% since the start of the year to trump a flat performance by S&P/ASX 200 index. The exchange operator’s stable earnings have offered investors a place of comfort as widely-held stocks like bank shares have floundered. While the sell side has generally panned ASX for having rich valuations, one analyst begs to differ. In fact, the analyst argues the stock offers a massive 44% upside if ASX, which is looking to upgrade its trading platforms, becomes a pioneer of blockchain technology among exchange operators.

Morgan Stanley analyst Daniel Toohey upgraded ASX from equal-weight to overweight on Thursday and lifted his target price from AUD43 a share to AUD50 a share. The analyst argues the bourse’s “defensive beta, growth levers and blockchain opportunity demand a P/E premium, yet ASX trades at a discount to peers.” Beta is a measure of a stock’s sensitivity to volatility in the broader stock market. Currently fetching around $45.80 a share, Australasia’s largest bourse trades at just shy of 21 times forward earnings, which is slightly below the 22 times for Singapore Exchange (
S68.SG
) and London Stock Exchange Group (
LSE.UK
), and well short of the 33 times on Hong Kong Exchanges & Clearing (
388.HK
). Toohey takes a different angle than other analysts, who reckon the ASX’s valuation looks stretched given its 19% premium to the S&P/ASX 200’s forward earnings multiple of around 17 times. However, it appears the norm is for exchanges to fetch higher valuations than the benchmark indices associated with those exchanges – LSE trades at a 30% premium to the FTSE100 index, while HKEx commands a massive 192% premium to the Hang Seng index.

Barron’s Asia coverage of the region’s stock exchanges

Adoption of blockchain technology could be a game changer for ASX. Put simply, a blockchain is a tamper-proof database (the chain) of all transactions (blocks) that take place within a network and is the key technology that underpins bitcoin and other forms of peer-to-peer (P2P) internet finance. For ASX, there could be multiple benefits to putting in place a digital vault of transactions shared between all market participants as it retires its legacy clearing and settlement system. Toohey says a blockchain-based system would lower costs for issuers and investors, which could boost trading activity on the ASX, shorten settlement times, which would free up capital, and create new opportunities to grow data and analytic services. “First movers on blockchain have potential to reshape business models, build competitive advantages and grow new revenue pools,” says the analyst. In the bull case scenario that ASX does successfully launch its blockchain, Toohey expects the stock to rise a towering 44% to AUD66.10 a share. ASX is currently gathering feedback with a prototype – a final decision on whether to proceed is expected in mid-2017.

Blockchain aside, ASX is a steady ship. “ASX is a high-quality company with high margins, strong cash flow generation and a strong competitive and market position,” notes JPMorgan analyst Siddharth Parameswaran. The company has averaged a 45% net profit margin and a 5.9% free cash flow yield for the past five years. It also pays a not-too-shabby 4.2% dividend on its current share price. Parameswaran, however, is underweight ASX with a AUD41.50 a share target price. The analyst cites slower growth in listings revenues, headwinds to derivatives revenues and interest income and higher expenses as reasons to be wary.

Listing revenues next year are expected to come under pressure given fees are set according to the ASX’s market capitalization at the end of every May. While an S&P/ASX200 index that was 7% lower than its level on the prior reset date will weigh on fees, Credit Suisse analyst Andrew Adams expects the pressure to be partially offset by a tiered pricing structure, likely re-pricing and new listings. Adams forecasts ASX to earn AUD2.19 a share in the year ending June 2016 and AUD2.21 a share in 2017, which implies 3.1% average annual growth and is in line with FactSet consensus estimates.

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